Week 16: Prat – Kenneth Rogoff and Carmen Reinhardt

by George_East on April 21, 2013

prat_iconThis Week’s Prats of the Week are Harvard Economists and gurus of austerity economics, Kenneth Rogoff and Carmen Reinhardt for not checking their sums

You would never know it from watching the BBC or reading the newspapers but the theoretical basis for austerity economics is extraordinarily thin.   The theoretical underpinning essentially rests on two (yes you read that correctly) academic papers.

The idea at the heart of this government’s economic policy is that you have to pursue contractionary measures (spending cuts and tax rises), even though the economy is in the mire, as this will ultimately prove expansionary.  Short term pain for long term gain.  It is argued that if you are brave enough to implement such measures now, private sector  confidence will return to the economy (or you can put it the other way round, you will see off the bond vigilantes) and growth will follow.

The policy has, of course, been a singular failure, as the modest growth inherited by the government in May 2010 now teeters on a triple dip recession (but that is the fault of the snow, or the Olympics or the royal wedding or the rain or Europe or something).

To the question how can contractionary policy be expansionary, isn’t that a contradiction in terms, George Osborne has always been able to say (and has frequently said) that it has been proven that if countries run high debt levels then their growth rates slow markedly.    Therefore you cannot have high deficits, even in times of recession, because this will add to the national debt level, which itself will inevitably mean radically lower levels of growth.  Ergo if you tackle the deficit and thereby the debt levels now, you will prevent this and contractionary policy will indeed be expansionary.

If you dig deeper, what this ‘proof’ consists of is a single highly influential paper by Harvard economists, Ken Rogoff and Carmen Reinhardt.   The paper published in 2010 (the very moment when the initial Gordon Brown inspired stimulus that got us out of the depths of the financial crisis was beginning to be abandoned), was entitled ‘Growth In the Time of Debt’.   This purported to study comprehensively the experience of  post-war economies and concluded:

median growth rates for countries with public debt over 90 percent of GDP are roughly one percent lower than otherwise; average (mean) growth rates are several percent lower.”

In a classic case of confirmation bias (ie it is what certain people wanted to hear) it immediately became one of the most cited economic studies in the world by both politicians and the media.  The Washington Post described the US economy as ‘near the 90 percent mark that economists regard as a threat to sustainable economic growth’.  Notice, not ‘two economists’,  or ‘some economists’  but just ‘economists’.   The paper had become conventional wisdom.

Now for those of us of a historical bent it always seemed a pretty weird conclusion.  After all the major European economies all had debt to GDP levels of far in excess of  90%  when they were experiencing their highest ever levels of growth in the 30 years after the Second World War.   However, these were not hacks writing for the right wing press, or clowns like Andrew ‘Weimar Germany is just round the corner unless we raise interest rates’ Sentance or Chicago School ideologues like John Taylor.  These were highly credentialed Harvard Economists, who had also authored, This Time It’s Different, one of the best of the books on the financial crisis of 2008-9.

Economists like Paul Krugman were able to identify obvious errors in their reasoning – such as the fact that they cited debt as the reason for the contraction in the economy in the US in the very immediate post-war years, when the far more obvious explanation was the War Economy coming to an end and mass demobilization.  However, this was at the edges and a question of interpretation.

Then this week saw the publication of a new paper:  Does High Debt Consistently Stifle Economic Growth:  A Critique of Reinhardt and Rogoff by a team at the University of Massachusetts.  Now, it is not often that a paper by academic economists critiquing a paper by other academic economists makes the news, but this was dynamite.

The new paper, had gone back over the underlying data used by Reinhardt and Rogoff (proudly provided by them, so sure were they of the quality of their work).

What the University of Mass team found was that Reinhardt and Rogoff had not only been very selective in the data they had chosen to include and exclude, but hilariously had, as a result of a coding error in their Excel spreadsheet, entirely excluded data from Denmark, Canada, Belgium Australia and Austria.  And when I say coding error, what I mean is that they averaged data from lines 30-44 in their spreadsheet, rather than 30-49 (this was not complicated stuff).

Once the Excel error was reversed  out and the odd exclusions were put back in the results looked very different indeed.  If you want to know how odd the exclusions were,  by the way, one example is New Zealand – the paper only used data from 1951 which showed a contraction in the Kiwi economy of -7.56%, but the period in which New Zealand had more than 90% debt was 1946-1951 and if you took the entire period the average growth rate was 2.58%.

The Univ of Mass paper concluded once it had redone the maths , that: ‘the average real GDP growth rate for countries carrying a public debt-to-GDP ratio of over 90 percent is actually 2.2 percent, not -0.1 percent as [Reinhart-Rogoff claim].  In other words 90%debt to GDP levels are not statistically significant at all.  Yep, virtually the whole theoretical basis for George Osborne’s economic policy is rooted in an academic study based on a dodgy Excel spreadsheet.    No wonder Gideon was in tears in the week.    If its effects weren’t so tragic, it would be hilarious.

And yes I know I said in the first paragraph, that the theoretical underpinning rested on two papers.    The other one, is even worse.  But that is for another day.

{ 1 comment… read it below or add one }

Mike Killingworth April 22, 2013 at 6:51 am

The theoretical basis for austerity economics is extraordinarily thin

You can take the word “austerity” out of that sentence and it’s still true. People just don’t like to talk about it. For that matter, medicine contents itself with smaller statistical samples than other disciplines – so small in many cases that the textbooks say you can’t trust them – when you might think that the opposite ought to be so.

Human beings, it seems, prefer a wrong answer to no answer at all.

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